Incoming! Part 2: Income Distribution Mechanics

“Money, it’s a gas. Grab that cash with both hands and make a stash.” – Pink Floyd, Money

Not so fast. Yes, many people receive income from their investments into their accounts, which they can reinvest, spend, or use to “make a stash.” However, my hunch is that very few investors understand how the income distribution process works and its impact on the investments themselves. While it’s not typically an issue, sometimes this lack of understanding can cause unnecessary concern. For example, in December 2021, our clients – or at least the ones who follow their accounts closely – awoke one morning to discover that one of their mutual funds had dropped -17% overnight.

If your initial reaction was, “Yikes! What happened to that fund?” you’re not alone, and that situation naturally led to some incoming client questions. But what if I told you that there was absolutely no issue with the investment and that the “loss” was simply a matter of optics related to an income distribution? That real-life situation is partially what prompted this current Alt Blend series. And with our income-generation basics in mind from Part 1, it’s what we’re going to continue learning more about today. Here we go…



If you’ve ever been married to a dividend, but that marriage didn’t work out… (okay, I’ll stop and let you run with that terrible joke if you so choose).

Investments operate on an ongoing basis, but liquid securities can be traded between investors on any given (trading) day, so there needs to be a straightforward way of deciding who gets the dividend or interest payments. The date on which a buyer of a stock is no longer entitled to receive the upcoming dividend is known as the “ex-dividend date.”

A simple way to think about this is that you’ll receive the upcoming dividend if you own the stock prior to the ex-dividend date. If you buy it on or after the ex-dividend date, it is just as it sounds: “without dividend.” And if you’d like to learn more about the process, Investopedia has a concise overview of the four dates involved (declaration date, ex-dividend date, record date, and payable date). The concept is similar for bonds, but it’s known as the “ex-coupon” date. As with the ex-dividend date, the ex-coupon date is when a bond trades without the upcoming (already declared) coupon.

As mentioned in the first part of this series, mutual funds can hold stocks and bonds (and many other investments), but the income from the underlying holdings has to be paid out to the fund’s shareholders. ETFs are different in that the fund may have the option to reinvest the dividend back into the underlying holdings rather than distribute cash to shareholders. Whether the income consists of dividends from underlying stocks or interest from underlying bonds, mutual funds, and ETFs pay their income distributions as dividends, and – just like stocks, they follow the ex-dividend protocol.

Sounds Easy, Right?

The good news is that you really won’t be paying for a dividend you won’t receive. Markets (as efficient pricing mechanisms) have developed a solution to this problem, depending on the particular type of holding. The bad news is – as alluded to with our example in the first paragraph – it can be confusing in two ways: 1. Potentially unexpected price movements around the time when significant dividends are paid (for this edition), and 2. How gains/losses are reflected on custodial platforms (which we’ll save for Part 3).

The Price We Pay for Income

The mere fact that some holdings pay income and some may not account for differences in the prices of those holdings in general. For example, an analyst can incorporate future dividends into a model that helps determine a fair price for a given stock. But that’s not what we’re interested in for this discussion. Instead, we’ll focus on the short-term implications of income distributions by investment type.

Stocks: As a reminder, dividends are a way for a company to share profits with shareholders. While they can be paid in additional shares of stock, dividends are typically paid in cash on a per-share basis. For example, your XYZ stock may pay you $1.00 for each share owned. If you own 100 shares, you get $100.

Before a dividend is paid, it is first declared by the company. That announcement results in investors being willing to pay a premium for the stock, and the price tends to move upward accordingly. However, once the stock goes ex-dividend, buyers are no longer willing to pay for the dividend (they won’t receive), so the price adjusts downward. The “really cool” (in finance nerd speak) aspect of these dividend-related adjustments is that they occur simply due to market forces. As usual, you can dive deeper into this topic if desired, and this Investopedia page provides a good overview.

Most importantly, these movements tend to go unnoticed because stock prices commonly exhibit some degree of volatility anyway. As such, I’ve never received a question about a dividend-driven stock-price movement.

Bonds: Unlike stocks, bonds still do not trade on open centralized exchanges. And what many investors probably don’t realize is that the process still essentially boils down to humans sitting at their respective Bloomberg Terminals (i.e., specialized financial data computers you’ve probably seen in the background on financial network TV) – often at bond desks of investment companies – striking deals with one another. As such, the traders will naturally incorporate every attribute possible into the price at which they are willing to buy (“bid”) or sell (“ask”) a given bond: e.g., maturity, whether it is secured or unsecured, seniority, coupon, taxation, whether it is callable, credit quality, etc. (learn more about all of those here). Interestingly (to me), all of that price negotiation and bond trading effectively sets the price of credit in the economy.

What traders also include in the bond pricing is – you guessed it – the timing of interest payments and who is entitled to receive the next one. After the bond goes ex-coupon, each day that passes is one day closer to the next coupon payment. As such, the bond price needs to reflect an incrementally higher value for the amount of the (eventual) coupon payment to which a buyer would be entitled. That additional value is known as “accrued interest.”

Some reporting systems reflect the price of the bond that includes the accrued interest (aka the “dirty price”), while others may show it without accrued interest (aka the “clean price”). Thus, one may or may not notice coupons affecting bonds prices, which may depend on the data they can view. In the case of systems that reflect accruals, the price will creep up until the ex-coupon date and then drop by the amount of the coupon payment, only to start the process once again.

Mutual Funds: Now that we understand how distributions affect stock and bond pricing, it will make the mutual fund discussion much more straightforward. A reasonable way to describe MF movements is more “stock-like” leading up to the ex-dividend date and more “bond-like” after going ex-dividend. BUT, I also think they have specific nuances that cause more investors to notice the impact of distributions more than other holdings.

You may recall that mutual funds only trade at the end of each day, and then a value (net asset value, or NAV) has to be set for the fund. All trades on a given day occur at that NAV determined after the trading day has ended. On the ex-date, the NAV declines by the dividend amount; this makes sense, as the value of the dividend is no longer part of the fund.

Regardless of the logic, an investor-only sees that the fund drops in value, and it feels like they’ve lost money. NAV fluctuation may not raise any red flags for more aggressive strategies, like equity funds, but it indeed can when more stable holdings pay dividends, like high-quality bond funds.

The time to particularly keep this lesson in mind is near year-end when capital gains are paid out from mutual funds. Those distributions may be larger than usual, and those larger distributions mean even larger declines in the fund’s NAV. Making matters worse, dividend payments may not occur until a couple of days after the ex-date. Thus, even savvy investors who review their account history may find no offsetting dividend payment to explain the price decline.

ETFs: ETFs tend to function very much like stocks in their response surrounding dividend payments, rising before the ex-date and then declining to reflect the lost value of the dividend. This behavior is unsurprising to me, given that they trade very much like stocks – intraday on centralized exchanges.

Limited Partnerships/Private Investments: Of the above liquid examples, private investments are most like mutual funds in that their prices may be adjusted explicitly for certain distributions. At the same time, if I’m a limited partner in a private equity fund, I may receive many types of income (e.g., capital gains proceeds, interest payments, royalties, revenue sharing from underlying businesses, rental income from real estate, etc.) without affecting the price of my investment. It’s also difficult to notice, as the fund may only strike monthly or quarterly NAV (or less often).

A simplified comparison for private investments is a landlord who rents out a house. The landlord doesn’t adjust the value of the rental property monthly because of receiving rent. The rent is collected, and, in normal times (not like the past year or two), the property value remains similar to what it was the prior month – and that value depends mainly on comparable property sales in the area (rather than the rent collection).

The one distribution of private investments where an investor will notice an effect on investment value is a “return of capital” (ROC) distribution. Just like it sounds, this is when the fund gives money back to investors, so the value tends to decline in lock-step with ROC payments.

In Part 3 of this series, we’ll continue exploring the impact of investment distributions, including a perspective on returns and taxation.

Until next time, this is the end of Alt Blend.

Thanks for reading,



The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

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About the Author

Steven Tresnan, CAIA®, CFP®

Private Wealth Advisor

Steve is a Certified Financial Planner as well as a Chartered Alternative Investment Analyst®. He is also an Accredited Investment Fiduciary, which helps him offer guidance to clients with fiduciary responsibilities, such as board members of trusts, foundations, and endowments. Steve earned a Bachelor of Science degree in Industrial Engineering from Penn State University.

Steve serves on the board and finance committee of New Music USA – a national nonprofit devoted to the development and appreciation of new music in the U.S. – and volunteers as the Treasurer for Campus Fun & Learn, a child development center on the campus of Rockland Community College in New York. 

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